Why Did So Many People Make So Many Ex Post Bad Decisions? The causes of the foreclosure crises

Here is an Article by the Fed about the foreclosure crises.

Fact 1: Resets of adjustable-rate mortgages did not cause the foreclosure crisis. The authors find that the 84% of these borrowers who went into foreclosure were making the same payment when they first defaulted as when they took out their loan. The conclusion: adjustable-rate loans performed worse than fixed-rate loans because they attracted less creditworthy borrowers, “not because of something inherent in the ARM contract itself.”

Fact 2: No mortgage was “designed to fail.” Instead, the products weren’t designed to sustain a drastic decline in home prices.

Fact 3: There was little innovation in mortgage markets in the 2000s. Loans that required reduced documentation (what became known as the “liar’s loan”) or that had negative amortization (the “pick-a-payment” loan) had been around in the 1980s and 1990s. Instead, what happened during the last decade was that these niche products became mainstream.

Fact 4: Government policy toward the mortgage market did not change much from 1990 to 2005. Low down payment loans were introduced by the government…in the 1940s. “It is impossible to find any government housing initiative in recent years that is remotely comparable” to the expansion of government’s expansion in the post-World War II period, the authors write.

Fact 5: The originate-to-distribute model was not new. Secondary mortgage markets, where investors bought loans from originators, had been around since the 1970s. And before that, mortgage companies had sold their loans to insurance companies.

Fact 6: MBS, CDOs, and other “complex financial products” had been widely used for decades. “The idea that the boom in securitization was some exogenous event that sparked the housing boom receives no support from the institutional history of the American mortgage market,” the authors write, though the types of collateral backing those products certainly did change.

Fact 7: Mortgage investors had lots of information. Of course, investors may simply have paid less attention to this information because many securities received triple-A ratings. (Some may take issue with this point due to the level of fraud that surprised many of the most well-informed market analysts).

Fact 8: Investors understood the risks. Some mortgage analysts had published “remarkably accurate predictions about losses” if home prices turned down. The bigger question, the authors raise, is that “given how badly these loans were expected to perform, why did investors buy them?”

Fact 9: Investors were optimistic about house prices. This helps answer the aforementioned question.

Fact 10: Mortgage market insiders were the biggest losers. The firms that were the most involved in the market and which retained the most risk on their balance sheet, either via whole loans (option adjustable-rate mortgages at Wachovia) or securitized loans (at Bear Stearns), fared the worst.

Fact 11: Mortgage market outsiders were the biggest winners. The “big shorts” such as John Paulson and Michael Burry were relative newcomers to the mortgage market. Their insight about a housing bubble and “not any fact about credit, the origination process, or moral hazard” led them to make their winning bets.

Fact 12: Top-rated bonds backed by mortgages did not turn out to be “toxic.” Top-rated bonds in collateralized debt obligations (CDOs) did.

Published by Stout Law Firm

I have passed three bar exams

Leave a Reply